Competitive depreciation and the role of distorting taxes in an interdependent economy

Abstract

This paper investigates the manners in which international cooperation in monetary policies affects the rate of inflation in a two-country sticky-price model. Within reasonable parameter values, international monetary coordination increases the steady-state inflation for given tax policies. When the tax regime is endogenously chosen, however, self-oriented monetary policies can engage in competitive depreciation and induce a higher average inflation than the first best inflation rate.